Corporation Cannot Deduct California Business Privilege Tax in Year Paid

Wells Fargo, an accrual-basis taxpayer, could not deduct the
California business privilege tax it paid in one year (year 1)
for the privilege of doing business the next year (year 2),
even though California law had, since 1972, treated the tax as
being incurred in year 1, a federal district court has held
(Wells Fargo & Co., No. 09-CV-2764 (D. Minn.
8/10/12)).

Until 2003, Wells Fargo had deducted the
business privilege tax in year 2, but chose to change its
treatment to deducting it in year 1 because the obligation to
pay those taxes and the amount of those taxes became fixed by
the end of year 1 (and Wells Fargo actually paid the tax in
year 1 through its estimated tax payments). These facts meant
that the “all-events test” by which an accrual-basis taxpayer
is able to deduct a liability was met.

The district court found that the all-events test had been
met; however, due to a quirk in the federal tax law, Wells
Fargo nevertheless could not deduct the tax in year 1. Under
Sec. 461(d), which governs the tax year in which a taxpayer
can take a deduction for accrued taxes, any change to a
state’s tax laws that occurs after Dec. 31, 1960, cannot
affect the timing of a deduction. As a result, the court had
to determine how California tax law before 1961 would have
treated the accrual of the business privilege tax.

Current California law requires a corporation to pay
business privilege tax calculated on the basis of its year 1
income for the privilege of conducting business in year 2,
even if the taxpayer discontinues operations before the end of
year 2. Before 1972, however, the amount of the corporation’s
tax liability would be reduced if it discontinued operations
in year 2.

Because liability for the California
business franchise tax before 1972 was contingent on actually
conducting business in California in year 2, the event that
would create the liability was not fixed for purposes of the
all-events test until year 2, according to the court, and
therefore the tax was not deductible until year 2.

Because Sec. 461(d) forbids post-1960 law changes from
affecting the timing of the deduction, Wells Fargo, therefore,
had to continue deducting its California business privilege
tax in year 2, even though current California law fixes
liability in year 1.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.